There comes a time in every person’s life when they face a quandary: Should I spend or should I save my surplus funds?
When you find yourself with surplus funds – whether the by-product of diligent budgeting, a raise or an unexpected windfall – your first instinct might be to throw caution to the wind and start splurging. But if you can resist the temptation to spend, utilizing those extra dollars wisely can be of great benefit to your financial situation both now and in the future.
Once you’ve made the decision to put your surplus funds to work, however, it can be difficult to know the best place to invest: a Registered Retirement Savings Plan (RRSP), a Registered Education Savings Plan (RESP), a Tax-Free Savings Account or paying down debt.
Your first step should be to ensure you’ve made your credit card and mortgage payments, and contributed the minimum reimbursement to the Home Buyers’ Plan (HBP), if you are a first-time homebuyer. Once you’ve gotten that in hand, it’s time to prioritize:
1. If You Don’t Have an Emergency Fund, You Should
Establishing an emergency fund should be the top of everyone’s financial to-do list. In case something unexpected should befall you (like a job loss, a furnace breakdown or a flood in the basement), this fund will protect you and keep you from falling into significant debt. A good rule of thumb is to have three months worth of expenses in your emergency fund, and the TFSA is a great vehicle for these savings, because the interest is tax-free. And note, if you’ve always considered your line of credit to be your emergency fund, keep in mind that if you have to dig into that line of credit repeatedly in order to deal with unforeseen expenses, what started as a small amount could balloon into a much more burdensome repayment situation over time.
2. Maximize the Portion of Your RESP That Entitles You to Government Grants
If you have children, give them a head start by investing in an RESP. In addition to helping you slowly and steadily fund your children’s education, RESPs allow you to defer taxes and split income with your child in the future, while taking advantage of available federal and provincial grants. (Your child can receive up to $500 per year through the Canada Education Savings Grant, for example.)
3. Pay Off Non-Deductible Debts (OR Contribute to Your RRSP)
Take a look at the interest rate on your non-deductible debts – if it is higher than the expected rate of return on an RRSP investment, pay down those debts first. If, on the other hand, your expected rate of return is higher than the interest rate on your borrowed funds, make an RRSP contribution first. This is where a trusted financial advisor can help you determine the best course of action.
4. Choose the Option Not Selected in Step 3
5. Make RESP Contributions That Are Not Eligible For Grants
Though you may have maxed out on the grants that your children are eligible for, you can still make additional RESP contributions. In the event that your children do not attend post-secondary education, the return generated in the RESP can be transferred to an RRSP (minus any grants).
6. Pay Back More Than the Minimum On Your HBP
If you used the Home Buyers’ Plan strategy for the purchase of your first home, you are annually required to make the minimum payment, which is 1/15 of the amount borrowed. However, surplus funds can also be put towards your HBP repayment to generate tax-sheltered income in your RRSP, should you have the money available. (These payments cannot be used as income tax deductions though.)
7. Make Non-Registered Investments
If you’ve followed all the previous steps and still have surplus funds, congratulations! You might now want to consider non-registered investments.
To ensure you are well-informed about the options listed here, it’s a good idea to consult with a financial advisor before embarking on any plan of action, says Marie C. Blanchet, Senior Consultant, National Bank of Canada, Financial Planning.
“We all become mired in day-to-day living, working, looking after children, paying the bills; sitting down with a financial advisor allows you to step back from all that and really see the big picture,” she says.
“A National Bank financial advisor will be able to help you identify your priorities and what really matters to you and your family, both now and in the long-term.”